The country may be in for a period of sluggish business growth, Federal Reserve Chairman Ben Bernanke told lawmakers Wednesday.

Bernanke also indicated that interest rates will be lowered again to try to steady the economy.

"The economic situation has become distinctly less favorable" since the summer, the Fed chief told the House Financial Services Committee. Incoming barometers continue to "suggest sluggish economic activity in the near term," Bernanke said.

Since his report last summer, the economy has slip-slided all around the board. The housing slump has worsened, credit problems have intensified and the job market has deteriorated.

At the same time, he added, the Fed must keep a close eye on inflation given the recent run-up in energy and other prices paid by consumers and businesses. For now though, the No. 1 battle is shoring up the economy.

Cautious Consumers

Bernanke said that the confluence of these factors has turned people and businesses alike toward a more cautious attitude toward spending and investment. This, he said, has further weakened the economy.

Bernanke promised to cut a key interest rate in an effort to help the wobbly U.S. economy. Many economists fear the economy is on the verge of a recession - or possibly has already toppled into one.

The Fed "will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks," Bernanke said, hewing closely to assurances he offered earlier this month.

The central bank, which began lowering a key interest rate in September, has recently turned much more aggressive. It has already slashed rates by 1.25 percentage points - the biggest one-month reduction in a quarter century. Economists and Wall Street investors predict the Fed will cut rates again at its next meeting on March 18.

Worries of Weakening Economy

But will the economy will weaken even further.

"The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further," Bernanke cautioned.

As Bernanke began his two days of testimony, there was also more bad news on the housing and manufacturing fronts.

- Sales of new homes fell in January for a third straight month -- the slowest pace in nearly 13 years, the Commerce Department reported. The median price of a new home dropped to the lowest level in more than three years.

- Orders to U.S. factories for big-ticket manufactured goods dropped in January by the largest amount in five months. On Wall Street, skittish investors sent the Dow Jones industrials down in morning trading.

The Fed chairman is hoping that previous rate reductions along with a $168 billion stimulus package of tax rebates for people and tax breaks for business will revitalize the economy in the second half of this year.

Shrinking Paychecks, Inflation Concerns

Even as the Fed tries to shore up the economy, it must remain mindful of inflation pressures, Bernanke said.

That's shrinking paychecks, and with people feeling less well off because the values of their homes have dropped, consumer spending "slowed significantly" toward the end of the year, the Fed chief said.

Inflation will moderate this year compared with last year, according to a Federal Reserve forecast.

The Fed's recently revised inflation projection now shows an increase between 2.1 percent and 2.4 percent. This prediction shows higher inflation than was forecast last fall.

Bernanke said there are "slightly greater upside risks" that inflation could turn out to be higher than the Fed currently anticipates, given the recent run-up in energy and food prices.

"Should high rates of overall inflation persist, the possibility also exists that inflation expectations could become less well anchored," he warned.

If people, companies and investors think inflation will move higher, they will act in ways that could turn inflation even worse, a sort of self-fulfilling prophecy.

And Bernanke said that could complicate the Fed's job of trying to nurture economic growth while also keeping inflation under control.

Twin Woes = Stagflation

With the economy slowing and prices rising, economists fear that the country could be headed for a bout of stagflation, a dangerous economic situtation not seen since the 1970s.

The Fed is now focusing on bolstering the economy through interest rate reductions. To combat inflation, the Fed would raise rates.

At some point over the course of this year, the Fed will need to "assess whether the stance of monetary policy is properly calibrated" to foster the Fed's objectives of price stability "in an environment of downside risks to growth," Bernanke said.